For proponents of sanctions on Russia, November got off to a good start. In the first week of the month, two events apparently increased the likelihood of stricter penalties being imposed.
First, the US State Department confirmed that the Kremlin had missed a deadline – set after the attempted assassination of Sergei Skripal in the UK – to respond to concerns about its use of chemical weapons. Then the following day, the US midterm elections delivered a majority for the Democrats in Congress.
Speculation mounted that investors would be forced to divest Russian sovereign bonds or that Russian state banks could be shut out of the international dollar system. Russian assets, already under pressure from the global emerging markets sell-off in October, came under further pressure.
Sanctions hawks may have been less encouraged by the events of the following week. On November 14, Gazprom became the first Russian borrower to tap the Eurobond market since the last sanctions escalation in April, raising €1 billion at a yield of less than 3%. A day later, state electricity producer RusHydro sold the first Russian corporate bond denominated in offshore renminbi.
While the latter deal at least will obviously have been months in the making, the emergence of the two bonds so soon after the US midterms looked pointed.
Gazprom’s ability to get a large deal done at a reasonable price in a difficult market environment highlighted investors’ conviction that the gas giant will remain immune to western sanctions for as long as Europe remains dependent on its products.
The choice of euros – while not a departure for Gazprom – also underlined the fact that Russian issuers have options beyond dollars and US investors, as did RusHydro’s dim sum market debut.
If the timing of the two deals was not entirely commercially driven, it would not be the first time the Russian state has used the bond markets to send a message to international policymakers.
In May 2016, Russia raised $1.75 billion in its first sovereign Eurobond outing since the imposition of sanctions two years earlier. The deal was completed despite the best efforts of US officials, who effectively prevented western banks from acting as bookrunners on the deal.
“In the past, Russia has used international placements to show that the country cannot be easily isolated on the international level,” says Gunter Deuber, head of CEE research at Raiffeisen Bank International.
He adds that in the event of more stringent penalties being introduced, Russia would likely repeat the exercise “to show its readiness to operate ‘normally’ under western sanctions”.
Comments from the head of Russia’s debt management office at an investor forum in London organized by the Moscow Exchange seemed to support this theory. Konstantin Vyshkovsky said the finance ministry would look to raise $3 billion to $7 billion in the Eurobond market annually for the next few years, despite running a healthy budget surplus on the back of resilient oil prices.
“We have no need to borrow in foreign currency but we believe it is useful to maintain Russia’s international market presence and support the yield curve for borrowers,” he said.
He was also keen to highlight that, even after heavy selling over the autumn, non-resident holdings of Russian domestic government bonds remained high at around 25% – something policymakers, along with many market participants, see as a hedge against extreme sanctions.
“I think the US will impose sanctions that are awkward but avoid a worst case scenario,” says an emerging markets banker. “They will want to make life difficult but without causing systemic risk to the global financial system.”
If anything, Russian private-sector companies have suffered more from concerns around sanctions escalation than their sovereign counterparts, following the US’s decision in April to target Kremlin-friendly oligarchs – in the form of Oleg Deripaska and Viktor Vekselberg – rather than the state itself.
If Russia’s opponents were hoping to unsettle bond markets with the threat of further sanctions, they may have been disappointed
Martin Kutny, a corporate credit analyst at Raiffeisen, says “idiosyncratic sanction premiums” are currently priced in to the bonds of companies including Novolipetsk Steel, Severstal, Norilsk Nickel, Metalloinvest and Polyus Gold.
At the same time, few would suggest that the Eurobond market is shut to Russian corporates. While some international investors may be avoiding Russian risk pending the resolution of sanctions uncertainty, those that are still buying have been starved of supply over the last six months.
Outflows from emerging market funds may have relieved some of the pressure on the market – but bankers say demand would likely still be sufficient to facilitate a few Eurobond sales.
“Overall international issuance from Russia remains at ultra-low levels,” says Deuber. “This year we have seen just $8 billion to $10 billion, versus a long-term average of around $20 billion.”
Whether or not Russian companies would be prepared to pay a premium for the privilege of raising funds in the Eurobond market, however, is another question. As Kutny notes, many higher-rated names currently have little need of foreign financing following recent deleveraging and a reduction in capex spending.
“Solid free cashflow generation and robust cash balances also point to an absence of any urgent need to tap the dollar markets on the part of most double- and triple-B credits,” he says.
If anything, bankers say, Russian companies see the current depressed valuations as an opportunity for bond buybacks rather than an obstacle to further issuance.
If Russia’s opponents were hoping to unsettle bond markets with the threat of further sanctions, they may have been disappointed.
While no one is discounting the risk of escalation, to date the most tangible result of the events of early November was a shortfall in demand for Russian domestic government bonds at the first auction after the US elections – which coincided with a fresh bout of global emerging markets volatility.
Will sanctions enthusiasts conclude from this – as Russian authorities apparently hope – that attempts to cut the country off from international debt markets are doomed to failure? Or will it prompt them to push for more extreme measures in the hope of making an impact?
Bankers and investors alike will be hoping for the former.